In brief:
- Known as the 'Great Wealth Transfer', it has been widely reported that over the next 30 years, we are expected to see an estimated £5.5 to £7 trillion passing from Baby Boomers to Millennials and Generation X.
- Against this backdrop, many families with family businesses are looking to the future and considering how best to protect their businesses and secure long-term growth for generations to come.
- The politics and dynamics that underpin family businesses make conscientious succession planning essential. Without it, family fall outs, adverse tax implications, disappointed inheritors, and, ultimately, business disputes become real risks. This article sets out practical tips for effective succession planning and avoiding deadlock in the family business.
Avoiding disagreements and deadlocks
Proactive succession planning begins with identifying and pre-empting where sources of tension and friction can arise in the running of a family business. Doing so makes it possible to plan and ensure the necessary mechanisms are in place to avoid those frictions escalating into a family dispute.
Board composition
Who sits on the board of directors is a common source of tension in family businesses. It can force parents into the uncomfortable position of having to side with one child over another or create rifts among siblings or cousins. It can also lead to potential deadlock where directors cannot agree on a decision or strategic direction for the business because the votes are tied and so the company becomes paralysed.
Deadlock arises if there are an even number of directors who vote equally on a resolution, and no director holds a casting vote. To mitigate against this risk, consider:
- Appointing an odd number of directors to the board, so a majority can usually be achieved (subject to any directors being conflicted on voting on particular matters); or
- Designating a casting vote to one director in the event of a tied decision. To assist in neutralising family disputes, it may be preferable to appoint an independent director.
- Including reserved matters provisions in the shareholders' agreement, so that certain decisions require unanimous shareholder approval, or so that designated shareholders hold a right of veto, preventing important company decisions from becoming deadlocked.
This will help necessary decisions to be made in the board room without it leading to argument around the dinner table.
Exit planning provisions in the shareholders' agreement
Mechanisms for smooth succession within a family business can and should be consolidated into the shareholders' agreement. This could include:
- Pre-emption rights on transfer - requiring a shareholder to first offer their shares to existing shareholders before they can transfer them to a third party. In the context of family businesses, these can prevent unwanted individuals, such as a child's estranged spouse, from acquiring a stake in the business without the consent of the wider family.
- Good and bad leaver provisions – defining the parameters of how shareholders can exit from the business can prevent disputes arising later down the line. The key distinction between the two lies in exit price, with a good leaver typically entitled to fair market value of their shares, whereas a bad leaver is often required to transfer their shares at nominal value or cost price.
- Divorce and relationship breakdown provisions – provisions can be included to prohibit transfers of shares to a spouse or civil partner, save with the prior written consent of the other shareholders. To ensure consistency across any pre/post nuptial agreements, taking specialist advice from a family lawyer is strongly recommended when drafting these provisions.
Valuation provisions
Having an agreed mechanism in place to value the business, or a particular shareholding, can be useful where a share buyout situation arises. Deciding on the value of a business is fraught with complexities, and disagreements can quickly become entrenched. The shareholders' agreement should set out a clear valuation methodology.
Dispute resolution mechanisms
Including a tiered dispute escalation and resolution clause in the shareholders' agreement, such as requiring the parties to attempt negotiation, expert determination and/or mediation before resorting to formal arbitration or litigation proceedings can provide a family with a clear pathway when a business dispute arises. Indeed, parties are expected to have considered whether the dispute can be resolved, including through alternative forms of dispute resolution (ADR) before any formal proceedings are issued. Having a well drafted dispute resolution clause gives family members a defined, formal forum in which to air grievances, helping to ringfence commercial disagreements from personal family conflict.
Review, review, review
The positions and dynamics within families constantly change and by their nature so too do the structure and operation of the family business. It is, therefore, even more important to keep the suite of documents that govern the business under regular review. In the case of family businesses, this extends beyond corporate documents to include any family charters, trust documents, wills and lasting powers of attorney, which should be reviewed alongside the shareholders' agreement and any other governing documents to ensure consistency.
A word of caution: mean what you say and then document what you say. If a conversation takes place between family members about succession, the inheritance of assets or future roles in the business, care should be taken to ensure any agreements or expectations are properly recorded.
Remedies when things do not go to plan
In the event succession within the family business does not unfold as intended, and cannot be resolved by ADR, there are a number of formal legal remedies that may be available to aggrieved family members.
- Proprietary estoppel is a legal claim that can make good on a broken promise in the context of proprietary rights. It can typically arise in circumstances where a family member has been led to believe that they will inherit a share in a particular proprietary asset, and they have acted to their detriment in reliance on that belief (such as working in the family business with little or no pecuniary benefit). For more information on proprietary estoppel please view our recent article here.
- Claims under the Inheritance (Provision for Family and Dependants) Act 1975 - Where a family member considers that reasonable financial provision has not been made for them on the disposition of a deceased's estate, they may be entitled to bring a claim under the 1975 Act. This can be a significant risk in the context of family businesses where shares or assets have been left in a particular way as part of a succession plan.
- Unfair prejudice claims - Under section 994 of the Companies Act 2006, a shareholder may petition the court on the grounds that the company's affairs have been conducted in a manner that is unfairly prejudicial to their interests. This remedy can be particularly relevant in the context of family businesses, where majority shareholders may seek to exclude minority shareholders from decision-making.
- Derivative claims – a shareholder may also bring a claim on behalf of a company for actions including negligence, breach of duty or breach of trust by a director of a company. This remedy can be effective for minority shareholders that have been excluded from the management of a family business and seek to hold a director accountable for conduct that has caused harm to the company.
These are just some of the potential remedies that may be available when succession planning breaks down. While preventive measures, as set out above, are always the preferred approach, when disputes do arise, early and decisive legal action can be critical to protecting both the business and family relationships. The sooner specialist advice is sought, the greater the prospects of achieving a swift and proportionate resolution, whether through negotiation, ADR, or, where necessary, formal proceedings.
If you would like to know more about how we can advise you and your family business on succession planning, please contact a member of the Private Commercial Litigation team.